LawrenceG. McMillan

The market, as measured by the Standard & Poor’s 500 Index made some huge swings lately.

Since the latest swing is to the upside, including three very strong days since the retest of the 1,820 lows last Thursday, the bulls are feeling superior while the bears are feeling inferior once again. But is it over? Is the market ready to rocket to the upside off what amounts — for all practical purposes — to be a “V” bottom? An examination of the intermediate-term indicators, plus some short-term signals should give us some clues.

Ironically, the most negative indicator at the moment is the price chart of the S&P 500 index
SPX, +0.59%
itself. That’s because it is still in a downtrend (see chart below). Today’s rally has carried SPX back to its declining 20-day moving average for the first time. It last touched that average on Sept. 25, before plunging about 180 points and now recovering. Usually, an oversold rally overshoots the declining 20-day moving average by a fairly small amount and then runs into trouble. That could well be happening now.

Today’s rally has also carried SPX back to the downtrend line that connects the row of lower highs in last September and early October. In the past couple of weeks, severe breakdowns occurred when SPX first violated the 1,960 level, and then later the 1,910 level. I would expect 1,960 to still represent resistance. As for support, it clearly exists at 1,820 — the double bottom formed by last week’s action and that of early April. Since the ensuing rally was so swift, there wasn't a chance to build any other support level on the way up the past few days.

One more thing about the SPX chart: a “modified Bollinger Band” (mBB) buy signal was given as of Friday’s close, Oct. 17. That’s because SPX had closed below the –4 sigma Band for four days but then closed above the –3 sigma Band on the 17th. That is a short-term buy signal, which obviously has worked so far. The short-term target of such a buy signal is the declining 20-day moving average, and that has nearly been attained. The larger target is the upper +4 sigma Band (currently near 2,010), but that target isn't always reached.

Equity-only put-call ratios raced upward as the market has plunged. As long as they trend higher, that is bearish for stocks. They have reached such lofty levels — the highest levels in over two years — that they have to be considered “oversold.” Any slacking off from the put buying (and we are beginning to see that now) would create buy signals from these important intermediate-term indicators. I would say that buy signals are imminent from these put-call ratios. They were quite accurate in calling the recent top, with sell signals on or about Sept. 22, and so any buy signals would need to be respected.

Market breadth has been weak since last July. In these columns, we’ve previously mentioned that cumulative breadth topped out at all-time highs in July, but SPX went on to make new highs nine more times after that. That was a negative divergence which has resulted in the current market decline. Now, however, breadth has improved to the state that our short-term breadth oscillators are on buy signals. That short-term action doesn’t mitigate the longer-term negative divergence that is in place, however.

Volatility indexes
VIX, -7.04%VXV, -3.18%
have mirrored the market’s wild behavior. They exploded to the upside last week, and now have collapsed to the downside. Amid that action, a VIX spike-peak buy signal was generated last Wednesday, Oct. 15. Those are generally powerful buy signals, and this one is certainly among that group. VIX spike-peak buy signals generate most of their profits in the first five trading days, but they do last for a month or so. Thus, there may be more upside from this signal. Also, VIX closing below 18 (which it looks like it will do today) is positive in that it aborts the uptrend that VIX had been in.

The construct of the VIX futures completely inverted last week, for the first time since the fall of 2011. That was a bearish sign, but it has now been mostly reversed, with a positive-sloping term structure back in place. All of the futures had traded at discounts to VIX last week, but now they all are at premiums, from November forward. November will be the front month VIX future, beginning tomorrow. So, the bottom line here is that it appeared that a bearish inversion was taking place, but is has been quashed, and the construct is back in the bullish camp once again. Amid this action, another short-term buy signal has been generated by VIX closing below VXV (the CBOE’s three-month volatility index).

In summary, the short-term bullish buy signals (mBB, VIX spike peak, and VIX crossover) have been strong. Their influence is short-term, but longer-term buy signals are beginning to fall into place, too: Breadth, the trend of VIX, and potentially the put-call ratios. All that is left is the chart of SPX itself.

Several times in this bull market, we have seen the opposite: Sell signals from the indicators, but a bullish price chart form SPX. In all of those cases, the chart of SPX was dominant. So, if it is to continue this dominance, the current rally will fail — despite what appears to be a strong underpinning from all of the recent buy signals.

What will it take to turn the SPX chart positive? In my opinion, a close above 1,960 would do it.

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